An Unchanged Unemployment Rate

Kash noted today’s good news on employment growth and provided a graph of the employment-population (EP) ratio, which increased from 62.4% to 62.6%. While this is the first time since October 2002 that this ratio has exceeded 62.5%, the unemployment rate did not fall. The following graph shows why I have argued that the unemployment rate can be a misleading indicator of labor market conditions. Simply put – the rise in the civilian labor force participation rate (LF) last month masked the goods news as far as new employment. The unemployment rate can be seen as one minus EP divided by LF.

Our graph shows how LF and EP have evolved since January 2000. During the 2001 recession and very weak partial recovery of 2002 and early 2003, the increase in the unemployment rate was less dramatic than the decline in EP as LF eroded. Some of the subsequent reduction in the unemployment rate is attributable to a rise in EP but some of it had been attributable to a continued erosion of LF. Now some Administration apologists (and not just this fellow) have tried to argue that the decline in labor force participation was voluntary, but many economists would argue much of the decline represented a discouraged worker effect.

Fortunately, we saw some improvement in the labor market this month, which showed up in higher EP and LF ratios. I’m on record for praying for a return to the days of having employment being 64% of the adult population. Let’s suppose some forecaster tells us his macroeconomic model predicts a 4.5% unemployment rate by the end of 2006. I’m sure some Administration apologists will go giddy with glee, but I’m going to look at the details as to what the forecaster is saying about the labor force participation rate. If the forecast is for LF = 67% so EP = 64%, I’ll join in the glee. But if the forecast is for LF = 66% so EP = 63%, I’ll continue to argue we should hold to higher standards before we declare full employment.

Update: CNN paints a rosy picture of the jobs market by noting two things. One item relates to the increase in average hourly work week even though 33.9 hours is still far below the level observed in 2000. The other alleged improvement relates to wages even if CNN’s reported increase in average weekly wages is mostly from the first statistic as nominal wages rose by only 0.3%. Memo to self: stop being so hard on the National Review as at least they are not responsible for those CNN/Money stories.